Chapter 8: Intangible Assets

Objective:

 Know the characteristics of intangible assets.

8.1 Definition of Intangible Assets

An intangible asset is a non-monetary asset without physical substance. Unlike tangible assets,
such as buildings and machinery, intangible assets cannot be seen or touched but still hold value
and provide future economic benefits. Common examples of intangible assets include:

 Patents
 Trademarks
 Copyrights
 Software
 Goodwill
 Licenses and franchises

Intangible assets are often valuable resources for a company, contributing to its competitive
advantage and long-term profitability.

8.2 Characteristics of Intangible Assets

To be classified as an intangible asset, the following characteristics must be met:

1. Identifiability: An intangible asset must be separable from the entity (i.e., capable of
being sold, transferred, or licensed) or arise from contractual or legal rights, regardless of
whether those rights are transferable or separable from the entity.
2. Control: The Company must have control over the intangible asset, meaning it has the
power to obtain future economic benefits from the asset and restrict others from
accessing those benefits.
3. Future Economic Benefits: The asset must be expected to generate future economic
benefits, such as revenue, cost savings, or improved business processes.

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 4. Non-physical Nature: As the term implies, intangible assets lack physical substance,
which distinguishes them from tangible assets like property, plant, and equipment.

8.3 Types of Intangible Assets

There are two broad categories of intangible assets:

1. Internally Generated Intangible Assets: These are created within the company through
its own research and development or other internal efforts. Examples include patents or
internally developed software. Internally generated intangibles are subject to stringent
recognition criteria under accounting standards.
2. Acquired Intangible Assets: These assets are purchased from external parties. Examples
include purchased patents, trademarks, and goodwill acquired through business
combinations.

8.4 Recognition of Intangible Assets

Intangible assets are recognized on the balance sheet when:

1. It is probable that future economic benefits attributable to the asset will flow to the
company.
2. The cost of the asset can be reliably measured.

Internally generated intangible assets must meet additional recognition criteria. For example,
development costs may be capitalized if they meet specific conditions, while research costs are
generally expensed as incurred.

8.5 Measurement of Intangible Assets

Intangible assets can be measured in two ways:

1. Cost Model: Intangible assets are carried at cost less any accumulated amortization and
impairment losses. This model is most commonly used.

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 o Amortization: The systematic allocation of the cost of an intangible asset over its
useful life. If the asset has a finite useful life, amortization is applied. If the asset
has an indefinite useful life (e.g., goodwill), it is not amortized but tested for
impairment annually.
2. Revaluation Model: Intangible assets are carried at a revalued amount, which is fair
value at the date of revaluation less any subsequent amortization and impairment losses.
This model is rarely used because it is difficult to reliably measure the fair value of
intangible assets.

8.6 Amortization of Intangible Assets

Amortization is similar to depreciation for tangible assets. It applies to intangible assets with a
finite useful life, meaning they have a limited period during which they provide economic
benefits. The amortization period reflects the asset's expected useful life, and the amortization
expense is recorded in the income statement over that period.

Example:
If a patent is purchased for ETB 100,000 and has a useful life of 10 years, the annual
amortization expense using the straight-line method would be:

𝐸𝑇𝐵 100,000
𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = = 𝐸𝑇𝐵 10,000 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
10

For intangible assets with an indefinite useful life (e.g., goodwill), amortization is not applied.
Instead, these assets are tested for impairment annually or when there is an indication that the
asset may be impaired.

8.7 Impairment of Intangible Assets

An impairment test is required for intangible assets when there is evidence that the asset may
have declined in value. For assets with indefinite useful lives, like goodwill, impairment testing
must be conducted annually. If the carrying amount exceeds the recoverable amount, an
impairment loss is recognized.

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Example:
A company holds a trademark with a carrying value of ETB 150,000. Due to changes in market
conditions, the recoverable amount of the trademark is now ETB 100,000. The company must
recognize an impairment loss of ETB 50,000.

Journal Entry:

Account Debit Credit

Impairment Loss ETB 50,000

Trademark ETB 50,000

8.8 Disclosure Requirements

Companies must disclose the following information regarding intangible assets:

1. The types of intangible assets owned and their carrying amounts.

Conclusion

Understanding the characteristics of intangible assets is essential for proper financial reporting.
These assets, while lacking physical form, often represent significant value to companies and
play a crucial role in business operations. Recognizing, measuring, amortizing, and testing
intangible assets for impairment ensures that financial statements accurately reflect their value
and contribution to a company’s profitability and future growth.

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Key Terms and Definitions

1. Intangible Asset: A non-monetary asset without physical substance that provides future
economic benefits.
2. Amortization: The process of allocating the cost of an intangible asset with a finite
useful life over its useful life.
3. Impairment: A loss in value of an asset when its carrying amount exceeds its
recoverable amount.
4. Internally Generated Intangible Assets: Intangible assets created within the company,
subject to stricter recognition criteria.
5. Goodwill: An intangible asset arising when a company acquires another and pays more
than the fair value of its identifiable net assets.

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